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Avoid the Inflation Penalty Box

November 17, 2022

Read Time 4 MIN

As part of this commentary, we point out 5 prevailing challenges for the market and inflation outlook and possible Fed actions in response to these challenges.

Don’t Focus on The Wrong Things: The Monthly CPI Report Distraction

Hockey season is here, and my favorite team, the New York Rangers, are off to a lackluster start. While disappointing, this provides a great opportunity to interject a sports analogy: hockey defensemen are taught to keep their eyes on the body, not the puck. The puck moves fast. Instead, focus on the shoulders to know where the puck is going.

Why is this relevant? The market seems to be “playing poor defense” by watching the puck. Every data point is overanalyzed to the point of exhaustion. The October CPI number came in at 0.40% versus expectations of 0.60%. The “better than expected” interpretation of the inflation report sent the U.S. 10-year Treasury note yield down from 4.09% to 3.84%, and, as a result, risky assets rallied.

The week before, the Federal Reserve (Fed) increased interest rates by another 75 basis points. Market strategists then feverishly went to work on Fed Chairman Jerome Powell. They dissected his mannerisms, the specific words he used, and the tone in which they were spoken. Mr. Powell’s perceived hawkishness sent interest rates higher and risky assets down.

The reality is that both of these events hardly provided any real insights. The uncertainty around inflation, interest rates, and a recession remain. That, however, does not stop the markets from overreacting. We believe the short-term focus of the markets creates opportunities.

Let’s Try It This Way: 5 Prevailing Challenges for the Market and Inflation Outlook

When contextualizing inflation, put yourself in a defenseman’s skates, and do not be mesmerized by the puck. Instead, focus on the body (problems) to anticipate where the puck (market) is going:

  1. Inflation remains very high but is decelerating
  2. Government debt is very high and continues to grow
  3. Historically, inflationary events have lasted a long time, with several peaks and troughs within
  4. The cure for inflation (tighter policy) is “kryptonite” to an overleveraged economy
  5. The Fed fights recessions with looser monetary policy, which is inflationary

Consequently, this leaves the Fed in the most unfortunate of economic situations with no great options. We have long said that the idea of a soft landing is a fairytale. Fed Powell now seemingly agrees and recently acknowledged that the window for a soft landing has “narrowed.”

The most reasonable outcome, in our view, is that the Fed will become less aggressive in its fight against inflation. More specifically, higher interest rates may eventually have a devastating impact on economic activity and the financial markets. We expect the Fed to be forced to pivot with inflation significantly higher than its 2% target. Ultimately, this inflation cycle will probably follow the predictable path of previous inflation cycles: It will last a long time!

The Best Defense is a Good Offense: Real Assets and High-Yielding Investments

Our preferred investment solutions to navigate the current environment are real assets and high-income generating assets. Real assets are time-tested inflation hedges. VanEck offers a broad suite of inflation-fighting assets. Amongst them, the VanEck Inflation Allocation ETF (RAAX) seeks to provide a “one-stop” solution to inflation protection.

The recent surge in interest rates has created compelling investment opportunities. The following chart demonstrates the advantages of high-income-generating investments in different inflation regimes.

Incoming! Average 3-Year Return of High Income Indices at U.S. CPI Above/Below 5%*

Incoming! Average 3-Year Return of High-Income Indices at U.S. CPI Above/Below 5%

Source: Bloomberg. Data as of September 30, 2022.*Note: time period of evaluation varies based on each index’s respective start date (Bloomberg U.S. Mortgage Backed Securities Index since January 1976; Bloomberg U.S. Corporate High Yield Bond Index since July 1983; J.P. Morgan EMBI Global Diversified Index since December 1993; Alerian MLP Index since December 1995). Benchmark index returns are not Fund returns and do not reflect any management fees or brokerage expenses. Certain indices may take into account withholding taxes. Investors cannot invest directly in the Index. Index descriptions included at the end of this presentation.

High inflation regimes, as defined as 5% or above, are typically associated with higher interest rates. Until recently, we have been critical of most income-generating assets because of low yields and surging interest rates. That has changed. There is likely limited upward mobility in interest rates from here and current yields offer a significant cushion against both inflation and future rate hikes. This has led us to launch the VanEck Dynamic High Income ETF (INC). It offers diversified income by actively allocating to high-yielding segments of the market. Learn more about INC in this Q&A.

Thank you for reading. We aim to provide you with thoughtful market insights and actionable investment ideas. This month’s insight was to look beyond the manic behavior of the markets and see the big trends. Remember, raise the cup by focusing on the body and not the puck!

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Important Disclosures

This is not an offer to buy or sell, or a solicitation of any offer to buy or sell any of the securities mentioned herein. The information presented does not involve the rendering of personalized investment, financial, legal, or tax advice. Certain statements contained herein may constitute projections, forecasts and other forward looking statements, which do not reflect actual results. Information provided by third–party sources are believed to be reliable and have not been independently verified for accuracy or completeness and cannot be guaranteed. Any opinions, projections, forecasts, and forward–looking statements presented herein are valid as of the date of this communication and are subject to change without notice. The information herein represents the opinion of the author(s), but not necessarily those of VanEck.

Bloomberg U.S. Mortgage Backed Securities (MBS) Index tracks fixed-rate agency mortgage backed pass-through securities guaranteed by Ginnie Mae (GNMA), Fannie Mae (FNMA), and Freddie Mac (FHLMC). The index is constructed by grouping individual TBA-deliverable MBS pools into aggregates or generics based on program, coupon and vintage.

Bloomberg U.S. Corporate High Yield Bond Index measures the USD-denominated, high yield, fixed-rate corporate bond market. Securities are classified as high yield if the middle rating of Moody's, Fitch and S&P is Ba1/BB+/BB+ or below. Bonds from issuers with an emerging markets country of risk, based on Bloomberg EM country definition, are excluded.

J.P. Morgan EMBI Global Diversified Index is an unmanaged, market-capitalization weighted, total-return index tracking the traded market for U.S.-dollar-denominated Brady bonds, Eurobonds, traded loans, and local market debt instruments issued by sovereign and quasi-sovereign entities.

Alerian MLP Index is the leading gauge of energy infrastructure Master Limited Partnerships (MLPs). It is a capped, float-adjusted, capitalization-weighted index, whose constituents earn the majority of their cash flow from midstream activities involving energy commodities.

Consumer Price Index is an index of the variation in prices paid by typical consumers for retail goods and other items. Bloomberg Commodity Index is a broadly diversified index that tracks the commodity markets through commodity futures contracts and is made up of exchange–traded futures on physical commodities, which are weighted to account for economic significance and market liquidity. S&P 500 Index is widely regarded as the best single gauge of large–cap U.S. equities. The index is a float–adjusted, market–cap–weighted index of 500 leading U.S. companies from across all market sectors including information technology, telecommunications services, utilities, energy, materials, industrials, real estate, financials, health care, consumer discretionary, and consumer staples.

Benchmark index returns are not Fund returns and do not reflect any management fees or brokerage expenses. Certain indices may take into account withholding taxes. Investors cannot invest directly in the Index. Returns for actual Fund investors may differ from what is shown because of differences in timing, the amount invested and fees and expenses. Index returns assume that dividends have been reinvested.

The S&P 500 Index is a product of S&P Dow Jones Indices LLC and/or its affiliates and has been licensed for use by Van Eck Associates Corporation. Copyright © 2022 S&P Dow Jones Indices LLC, a division of S&P Global, Inc., and/or its affiliates. All rights reserved. Redistribution or reproduction in whole or in part are prohibited without written permission of S&P Dow Jones Indices LLC. For more information on any of S&P Dow Jones Indices LLC’s indices please visit www.spglobal.com/spdji/en/. S&P® is a registered trademark of S&P Global and Dow Jones® is a registered trademark of Dow Jones Trademark Holdings LLC. Neither S&P Dow Jones Indices LLC, Dow Jones Trademark Holdings LLC, their affiliates nor their third party licensors make any representation or warranty, express or implied, as to the ability of any index to accurately represent the asset class or market sector that it purports to represent and neither S&P Dow Jones Indices LLC, Dow Jones Trademark Holdings LLC, their affiliates nor their third party licensors shall have any liability for any errors, omissions, or interruptions of any index or the data included therein.

An investment in the VanEck Inflation Allocation ETF (RAAX) may be subject to risks which include, among others, in fund of funds risk which may subject the Fund to investing in commodities, gold, natural resources companies, MLPs, real estate sector, infrastructure, equities securities, small–and medium–capitalization companies, foreign securities, emerging market issuers, foreign currency, credit, interest rate, call and concentration risks, derivatives, cryptocurrency, cryptocurrency tax, all of which may adversely affect the Fund. The Fund may also be subject to affiliated fund, U.S. Treasury Bills, subsidiary investment, commodity regulatory (with respect to investments in the Subsidiary), tax (with respect to investments in the Subsidiary), risks of ETPs, liquidity, gap, cash transactions, high portfolio turnover, model and data, management, operational, authorized participant concentration, no guarantee of active trading market, trading issues, market, fund shares trading, premium/discount and liquidity of fund shares, and non–diversified risks. Foreign investments are subject to risks, which include changes in economic and political conditions, foreign currency fluctuations, changes in foreign regulations, and changes in currency exchange rates which may negatively impact the Fund's returns. Small–and medium–capitalization companies may be subject to elevated risks.

An investment in the VanEck Dynamic High Income ETF (INC) may be subject to risks which include, among others, fund of funds, ETPs, U.S. treasury securities, interest rate, income, high portfolio turnover, management, operational, authorized participant concentration, absence of prior active market, trading issues, market, fund shares trading, premium/discount, liquidity of fund shares, affiliated fund, new fund, and non-diversified risks. The Fund may also be subject to dividend paying securities, investing in foreign securities, investing in emerging market issuers, foreign currency, investing in mortgage REITs, preferred securities, CLO, credit, high yield securities, interest rate, call and concentration risks, all of which may adversely affect the Fund.

Investing involves substantial risk and high volatility, including possible loss of principal. An investor should consider the investment objective, risks, charges and expenses of the Fund carefully before investing. To obtain a prospectus and summary prospectus, which contains this and other information, call 800.826.2333 or visit vaneck.com. Please read the prospectus and summary prospectus carefully before investing.

©️ Van Eck Securities Corporation, Distributor, a wholly owned subsidiary of Van Eck Associates Corporation.

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